-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VOkSAyd6pCyMY7uAXGBIryLj1E8vfWPe8XOoOiRaRBAi47iaJqmbTeUMLvmvPnji /laNITsSfC855S93PFbKUg== 0001047469-99-031998.txt : 19990816 0001047469-99-031998.hdr.sgml : 19990816 ACCESSION NUMBER: 0001047469-99-031998 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990703 FILED AS OF DATE: 19990813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL ORIGIN INC CENTRAL INDEX KEY: 0000805574 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 680101300 STATE OF INCORPORATION: CA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-18690 FILM NUMBER: 99689556 BUSINESS ADDRESS: STREET 1: 460 E.MIDDLEFIELD ROAD CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043- BUSINESS PHONE: 6504046000 MAIL ADDRESS: STREET 1: 460 E MIDDLEFIELD RD CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 FORMER COMPANY: FORMER CONFORMED NAME: RADIUS INC DATE OF NAME CHANGE: 19920703 10-Q 1 FORM 10-Q - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JULY 3, 1999. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13(d) OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______. COMMISSION FILE NUMBER: 0-18690 DIGITAL ORIGIN, INC. (FORMERLY RADIUS INC.) (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 68-0101300 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 460 E. MIDDLEFIELD ROAD MOUNTAIN VIEW, CA 94043 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE) (650) 404-6000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) -------------------------------------- INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO --- --- THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK ON AUGUST 11, 1999 WAS 5,554,498. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- DIGITAL ORIGIN, INC. INDEX
PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets at June 30, 1999 (unaudited) and September 30, 1998 3 Consolidated Statements of Operations for the Three and Nine Months Ended June 30, 1999 and 1998 (unaudited) 4 Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 1999 and 1998 (unaudited) 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 PART II. OTHER INFORMATION Item 1. Legal Proceedings 17 Item 5. Other Information 17 Item 6. Exhibits and Reports on Form 8-K 17 SIGNATURES 18
-2- PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DIGITAL ORIGIN, INC. CONSOLIDATED BALANCE SHEETS (in thousands)
JUNE 30, SEPTEMBER 30, 1999 1998 (1) --------- ------------- (unaudited) ASSETS: Current assets: Cash $ 3,121 $ 600 Accounts receivable, net 1,446 364 Note receivable from Korea Data Systems America, Inc. 350 4,500 Inventories 264 803 Prepaid expenses and other current assets 86 156 --------- --------- Total current assets 5,267 6,423 Property and equipment, net 48 133 Other assets 188 - --------- --------- $ 5,503 $ 6,556 --------- --------- --------- --------- LIABILITIES AND SHAREHOLDERS' EQUITY (Net capital deficiency): Current liabilities: Accounts payable $ 1,864 $ 1,971 Accrued payroll and related expenses 404 324 Other accrued liabilities 1,097 2,069 Deferred income 350 4,833 Accrued income taxes 301 1,102 Short-term borrowings - 1,340 --------- --------- Total current liabilities 4,016 11,639 Accrued income taxes 800 - Shareholders' equity (Net capital deficiency): Common stock 169,183 169,102 Accumulated deficit (168,496) (174,185) --------- --------- Total shareholders' equity (Net capital deficiency) 687 (5,083) --------- --------- $ 5,503 $ 6,556 --------- --------- --------- ---------
(1) The balance sheet at September 30, 1998 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. See accompanying notes. -3- DIGITAL ORIGIN, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data; unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------ 1999 1998 1999 1998 ---- ---- ---- ---- Net sales $3,660 $3,823 $ 9,077 $13,514 Commissions and royalties 122 47 172 911 ------ ------ ------- ------- Total net sales 3,782 3,870 9,249 14,425 Cost of sales 1,257 2,223 3,367 9,283 ------ ------ ------- ------- Gross profit 2,525 1,647 5,882 5,142 ------ ------ ------- ------- Operating expenses: Research and development 677 737 1,966 2,051 Selling, general and administrative 1,828 1,661 5,220 5,474 ------ ------ ------- ------- Total operating expenses 2,505 2,398 7,186 7,525 ------ ------ ------- ------- Income (loss) from operations 20 (751) (1,304) (2,383) Other income, net 1,794 4,715 7,048 10,211 Interest expense - (78) (55) (416) ------ ------ ------- ------- Income before income taxes 1,814 3,886 5,689 7,412 Provision for income taxes - - - - ------ ------ ------- ------- Net income $1,814 $3,886 $ 5,689 $ 7,412 ------ ------ ------- ------- ------ ------ ------- ------- Net income per share: Basic net income per share $ 0.33 $ 0.70 $ 1.03 $ 1.34 ------ ------ ------- ------- ------ ------ ------- ------- Diluted net income per share $ 0.32 $ 0.70 $ 1.00 $ 1.33 ------ ------ ------- ------- ------ ------ ------- ------- Shares used in per share computations: Shares used in computing basic net income per share 5,527 5,529 5,525 5,519 ------ ------ ------- ------- ------ ------ ------- ------- Shares used in computing diluted net income per share 5,723 5,546 5,669 5,566 ------ ------ ------- ------- ------ ------ ------- -------
See accompanying notes. -4- DIGITAL ORIGIN, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (in thousands, unaudited)
NINE MONTHS ENDED JUNE 30, -------------------- 1999 1998 ----- ---- Cash flows from operating activities: Net income $ 5,689 $ 7,412 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 94 115 Gain on the sale of Splash Common Stock - (9,016) Gain on the sale of the Color Server Group and other assets to Splash (2,485) - Gain on the monitor license and sale of other assets to KDS (4,152) - Loss on disposal of fixed assets - 25 (Increase) decrease in assets: Accounts receivable (1,082) 165 Note receivable 4,150 - Inventories 539 (276) Prepaid expenses and other current assets 70 (16) Increase (decrease) in liabilities: Accounts payable (107) (107) Accrued payroll and related expenses 80 (880) Other accrued liabilities (972) (1,063) Deferred income (4,483) - Accrued restructuring costs - (1,536) Accrued income taxes (1) 11 ------- -------- Total adjustments (8,349) (12,578) ------- -------- Net cash used in operating activities (2,660) (5,166) Cash flows from investing activities: Capital expenditures (9) (1) Other assets (188) - Net proceeds from the sale of Splash and UCC Common Stock - 8,288 Net proceeds on the sale of the Color Server Group and other assets to Splash 2,485 - Net proceeds from the monitor license and sale of other assets to KDS 4,152 500 ------- -------- Net cash provided by investing activities 6,440 8,787 Cash flows from financing activities: Short-term borrowings, net (1,340) (3,041) Principal payments of long-term debt and capital leases - (273) Issuance of common stock 81 108 ------- -------- Net cash used in financing activities (1,259) (3,206) ------- -------- Net increase (decrease) in cash and cash equivalents 2,521 415 Cash and cash equivalents, beginning of period 600 773 ------- -------- Cash and cash equivalents, end of period $ 3,121 $ 1,188 ------- -------- ------- -------- Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ - $ 427 ------- -------- ------- -------- Income taxes $ 1 $ 8 ------- -------- ------- -------- Non-cash investing activity: Receivable from sale of shares of Splash Technology Holdings, Inc. $ - $ 728 ------- -------- ------- --------
See accompanying notes. -5- DIGITAL ORIGIN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The consolidated financial statements of Digital Origin, Inc. ("Digital Origin" or the "Company") as of June 30, 1999 and for the three and nine months ended June 30, 1999 and 1998 are unaudited. In the opinion of management, the consolidated financial statements reflect all adjustments (consisting only of normal recurring items) necessary for a fair presentation in conformity with generally accepted accounting principles. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Examples include provisions for returns and bad debts and the length of product life cycles. Actual results may differ from management's estimates. Results for the three and nine months ended June 30, 1999 will not necessarily indicate the results to be expected for the fiscal year ending September 30, 1999 or any other future period. The information included in this Form 10-Q should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1998. For clarity of presentation, all fiscal periods are reported as ending on a calendar month end. NOTE 2. INVENTORIES Inventories, stated at the lower of cost or market, consist of (in thousands):
JUNE 30, SEPTEMBER 30, 1999 1998 --------- ------------- (unaudited) Raw materials $ 2 $ 20 Work in process 68 238 Finished goods 194 545 ---- ---- $264 $803 ---- ---- ---- ----
NOTE 3. COMMITMENTS AND CONTINGENCIES (a) On January 13, 1999 and January 28, 1999, the Company and one of its former directors, Charles Berger, were named as defendants in two shareholder class action lawsuits against Splash Technology Holdings, Inc. ("Splash"), various directors and executives of Splash and certain selling shareholders of Splash. The suits were filed in the United States District Court in Northern District of California and have been consolidated and captioned IN RE SPLASH TECHNOLOGY HOLDINGS INC. SECURITIES LITIGATION (Master File No. C99-0109 SBA). The law firm of Milberg Weiss Bershad Hynes & Lerach LLP has been designated lead counsel for the eight lead plaintiffs. The lawsuit alleges, among other things, that the defendants made or were responsible for material misstatements, and failed to disclose information concerning Splash's business, finances and future business prospects in order to artificially inflate the price of Splash Common Stock. The complaint does not identify any statements alleged to have been made by either Digital Origin or Charles Berger. The complaint further alleges that Digital Origin (then Radius Inc.) engaged in a scheme to artificially inflate the price of Splash Common Stock to reap a large return on the sale of the Common Stock in order to pay off the Company's substantial debt. Digital Origin and Charles Berger vigorously deny all allegations of wrongdoing and intend to aggressively defend themselves in these matters. Defendants filed a motion to dismiss the action on June 11, 1999 that is scheduled for hearing on October 19, 1999. (b) On July 18, 1997, Intelligent Electronics, Inc. and its affiliates filed a suit in the United States District Court for the District of Colorado alleging a breach of contract and related claims in the approximate amount of $800,000, maintaining that the Company failed to comply with various return, price protection, inventory balancing and marketing development funding undertakings. In 1997, the Company filed an answer to the complaint and cross-claimed against the plaintiffs and in October 1997 additionally cross claimed against Deutsche Financial, Inc., a factor in the account relationship between the Company and the plaintiffs, seeking the recovery of approximately $2 million. -6- The Company continues to investigate these claims as well as cross claims and expects to vigorously defend and prosecute them as applicable. This case is scheduled for trial on November 8, 1999. The Company has provided reserves for the full amount of accounts receivable due from Intelligent Electronics, Inc. and Deutsche Financial, Inc. (c) The Company is involved in a number of other judicial and administrative proceedings incidental to its business. The Company intends to defend such lawsuits vigorously and although adverse decisions (or settlements) may occur in one or more of such cases, the final resolution of these lawsuits, individually or in the aggregate, is not expected to have a material adverse effect on the financial position of the Company. However, depending on the amount and timing of an unfavorable resolution of these lawsuits, it is possible that the Company's future results of operations or cash flows could be materially adversely affected in a particular period. In addition, the costs of defense, regardless of the outcome, could have a material adverse effect on the results of operations and financial condition of the Company. NOTE 4. LICENSING OF ASSETS TO KOREA DATA SYSTEMS AMERICA, INC. In June 1998, the Company licensed certain technology and assets necessary to conduct its monitor and color publishing business to Korea Data Systems America, Inc. ("KDS"), leaving the Company free to focus on its digital video software business. The brand name and trademark RADIUS was one of the assets so licensed because of its primary association with monitors. In August 1998, the Company amended and restated this license and agreed to sell the licensed assets to KDS pursuant to an asset transfer agreement, subject to certain contingencies at the discretion of KDS. The monitor business has accounted for substantially all of the revenues of the color publishing product line and 55.3% of the Company's revenues during fiscal 1998. Under the license and asset transfer agreement, the Company transferred its Radius, Supermac, PressView and certain other trademarks to KDS and licensed certain intellectual property pertaining to PressView and PrecisionView monitors. The expected value of the transaction is $6.2 million to be paid in installments. As of June, 1999, $5.9 million was paid under the license and asset transfer agreement. On May 17, 1999, the Company completed the sale of its monitor and color publishing business to Korea Data Systems America, Inc. In connection with this transaction, the Company received the sum of $1.0 million which represents three installment payments on the note related to the license agreement. As of June 30, 1999, the remaining balance receivable under the agreement was $0.3 payable through July 1999, which is included as note receivable and deferred revenue in the accompanying Consolidated Balance Sheets. The Company will recognize other income under the license agreement as cash is received on the note. In July 1999, the Company received the final installment on the note. On December 4, 1998, the Company and KDS supplementally agreed to the sale of certain tangible personal property and the transfer of rights in the Radius Emachines and Colormatch trademarks for $100,000 and other consideration. -7- NOTE 5. TECHNOLOGY PURCHASE FROM POST DIGITAL SOFTWARE, INC. On November 23, 1998, the Company acquired certain software and other intangible property from Post Digital Software, Inc. for (i) an initial payment of $50,000, (ii) earnout payments equal to at least $50,000 but not exceeding $700,000 based on subsequent sales of the Company's digital video products incorporating such software and (iii) a warrant to purchase up to 50,000 shares of the Company's Common Stock at an exercise price of $1.50 per share. The warrant is non-forfeitable and exercisable over a four year period through November 23, 2002. The warrant can be exercised for up to 12,000 shares as of May 1, 1999, plus an additional 2,000 shares for each full month that transpires thereafter, up to a total of 50,000 shares. The value of this agreement, as noted below, is included as other assets in the accompanying Consolidated Balance Sheet. The technology is being amortized over a three year period and future royalties based on digital video products sold will be expensed as they are incurred. As of June 30, 1999, the Company has accrued approximately $14,000 in royalties. Initial purchase price $ 50,000 Guaranteed earnout 50,000 Value assigned to warrant 50,000 -------- Purchased technology 150,000 Less amortization (4,167) -------- Net purchased technology $145,833 -------- --------
NOTE 6. TRANSACTIONS WITH SPLASH TECHNOLOGY HOLDINGS, INC. ESCROW FUND RELEASE In connection with the Company's sale of its Color Server Group to Splash Technology Holdings, Inc. in January 1996, an escrow fund was established to secure certain indemnification obligations. On December 31, 1998, the balance of the escrow fund of approximately $2.2 million was released to the Company as a result of the Federal Circuit Court affirming the summary judgment in favor of the Company in the EFI litigation. The Company used approximately $1.0 million of the proceeds to repay all outstanding indebtedness to Silicon Valley Bank under the working capital line of credit. SALE OF CERTAIN COLOR PUBLISHING TECHNOLOGY On December 4, 1998, the Company agreed to sell certain software and other intangible property associated with its monitor and color publishing business to Splash Technology Holdings, Inc. for $275,000 and other consideration. NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, FASB issued SFAS 131, "Disclosures about Segments of an Enterprise and related Information." This statement establishes standards for the way companies report information about operating segments in financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The disclosures prescribed by SFAS 131 will be adopted for the fiscal year ending September 30, 1999. In December 1998, the American Institute of Certified Public Accountants issued SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions." SOP 98-9 amends SOP 97-2 and SOP 98-4 extending the deferral of the application of certain provisions of SOP 97-2, amended by SOP 98-4, through fiscal years beginning on or before March 15, 1999. All other provisions of SOP 98-9 are effective for transactions entered into in fiscal years beginning after March 15, 1999. The Company has not yet determined the effect of the final adoption of SOP 98-9 on its financial condition or results of operations. -8- NOTE 8. EARNINGS PER SHARE Basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of employee stock options and warrants using the treasury stock method. The following table shows the computation of basic and diluted earnings per share:
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------ ----------------- 1999 1998 1999 1998 ------ ------ ------ ------ (in thousands, except per share data) NUMERATOR: Numerator for basic and diluted earnings per share Net income $1,814 $3,886 $5,689 $7,412 ------ ------ ------ ------ ------ ------ ------ ------ DENOMINATOR: Denominator for basic earnings per share - weighted-average shares outstanding 5,527 5,529 5,525 5,519 Effect of dilutive securities: Employee stock options 146 17 111 47 Warrants 50 - 33 - ------ ------ ------ ------ Dilutive potential common shares 196 17 144 47 Denominator for diluted earnings per share - adjusted weighted-average shares outstanding 5,723 5,546 5,669 5,566 ------ ------ ------ ------ ------ ------ ------ ------ Basic earnings per share $ 0.33 $ 0.70 $ 1.03 $ 1.34 ------ ------ ------ ------ ------ ------ ------ ------ Diluted earnings per share $ 0.32 $ 0.70 $ 1.00 $ 1.33 ------ ------ ------ ------ ------ ------ ------ ------
-9- NOTE 9. COMPREHENSIVE NET INCOME As of October 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income." SFAS 130 requires foreign currency translation adjustments and changes in the fair value of available-for-sale-securities to be included in comprehensive income. However, it has no impact on the net income or stockholders' equity as presented in the financial statements. The components of comprehensive net income, net of tax, are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------- 1999 1998 1999 1998 ------ ------ ------ -------- Net income $1,814 $3,886 $5,689 $ 7,412 Unrealized loss on available-for-sale-securities - (758) - (12,078) ------ ------ ------ -------- Comprehensive net income (loss) $1,814 $3,128 $5,689 $ (4,666) ------ ------ ------ -------- ------ ------ ------ --------
NOTE 10. OPERATING LEASE The Company has signed an operating lease for its headquarters in Mountain View, California, for a period of three years beginning April 15, 1999, with an option to extend the lease for an additional two years. The base rent will be $25,000 per month the first year, $27,500 the second year and $30,000 for years three through five, if extended. NOTE 11. 1999 EMPLOYEE STOCK PURCHASE PLAN The Company's Employee Stock Purchase Plan allows eligible employee participants to purchase shares of the Company's Common Stock at a discount through payroll deductions. Employees purchase shares at 85% of the market value at either the beginning of the offering period or the end of the purchase period, whichever price is lower. The plan consists of one year offering periods with two six-month purchase periods in each offering period. The Company has reserved 137,500 shares of its Common Stock for issuance under the plan, in addition to 15,900 shares reserved under the previous plan. -10- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS: The following discussion contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 that are subject to risks and uncertainties. Statements indicating that the Company or management "intends", "plans", "expects," "estimates" or "believes" are forward-looking, as are all other statements concerning future financial results, product offerings or other events that have not yet occurred. There are several important factors that could cause actual results or events to differ materially from those anticipated by the forward-looking statements contained in this discussion and other sections of this Form 10-Q. Such factors include, but are not limited to: the Company's ability to sustain profitability; the Company's ability to successfully conclude its litigation with Intelligent Electronics, Inc. and Splash shareholders; the success of the Company's digital video software products; the success of the Apple Macintosh computer line and operating system, the success of Apple, as well as the Company's ability to compete successfully with Apple in its markets, including the non linear digital video editing software market; the success of Apple's Quicktime technology for Windows; favorable licensing terms for Quicktime from Apple; the Company's reliance on Adobe Systems for products which are bundled with the Company's products; the Company's ability to successfully develop, introduce and market new software products, including products for the Windows operating system, to keep pace with technological innovation, particularly in light of its limited financial resources; the Company's ability to compete in the digital video software market, including with Apple; the ability of the Company's manufacturers and suppliers to deliver components and manufacture the Company's products; the Company's ability to achieve Year 2000 readiness in its business operations and its dealings with significant third parties; the Company's reliance on international sales and its new distributor arrangements with respect to Europe and Japan and with Canon; and the Company's ability to attract and retain its key personnel. Each forward-looking statement should be read in conjunction with the entire consolidated interim financial statements and the notes thereto in Part I, Item 1 of this Quarterly Report, with the information contained in Item 2, including, but not limited to, "Certain Factors That May Affect Future Results," and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1998, including, but not limited to, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Certain Factors That May Affect the Company's Future Results of Operations." OVERVIEW The Company designs, develops, assembles, markets and supports digital video computer products for creative professionals and consumers who use digital camcorders. The Company's current product line includes: multimedia authoring and editing video systems and software that can acquire and manipulate video and audio information. The primary target markets for the Company's products are video editors, video producers, and creators of multimedia. These markets encompass creative professionals involved in such areas as multimedia authoring, video editing, video and multimedia production and corporate training. Historically, substantially all of the Company's products have been designed for and sold to users of Macintosh computer products (the "Macintosh") manufactured by Apple Computer, Inc. ("Apple") as Apple products have been the preferred platform in the Company's target markets. During fiscal 1998, the Company added cross platform (Windows and Macintosh) capabilities to many of the Company's products in order to market these products to users of the Windows operating system. Sales made to cross-platform users were 19% of digital video net sales in the fourth quarter of fiscal 1998. This compares to 31%, 31% and 56% of digital video net sales to cross-platform users in the first, second and third quarter of fiscal 1999, respectively. For the quarter ended June 30, 1999, the Company had an operating profit of $20,000. However, as shown in the accompanying consolidated financial statements, the Company had incurred substantial operating losses in prior quarters. During fiscal 1997 and 1998, management implemented a number of actions to address its cash flow and operating issues including: refocusing its efforts on providing solutions for digital video customers; discontinuing sales of mass market and other low value added products; divesting a number of businesses and product lines, including most recently the agreement for the sale and related license of significant assets of its monitor business to Korea Data Systems America, Inc. ("KDS"); significantly reducing expenses and headcount; and reducing its lease obligations given its reduced occupancy requirements. -11- There can be no assurance that these measures will be sufficient to allow the Company continued success in achieving profitability. As of June 30, 1999, the Company had working capital of $1.3 million. The Company intends to finance its existing working capital needs through cash, and cash equivalents, and cash generated by operations. The Company may need to further reduce its operating expenses or seek additional sources of working capital or additional equity if software product sales do not increase at the rate assumed in the Company's current operating plans or if the Company increases its working capital needs. RESULTS OF OPERATIONS The following table sets forth for the periods indicated certain operational data as a percentage of net sales (may not add due to rounding).
THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, 1999 1998 1999 1998 ---- ---- ---- ---- Net sales 100.0% 100.0% 100.0% 100.0% Cost of sales 33.2 57.4 36.4 64.4 ----- ----- ----- ----- Gross profit 66.8 42.6 63.6 35.6 ----- ----- ----- ----- Operating expenses: Research and development 17.9 19.1 21.3 14.2 Selling, general and administrative 48.3 42.9 56.4 37.9 ----- ----- ----- ----- Total operating expenses 66.2 62.0 77.7 52.1 ----- ----- ----- ----- Income (loss) from operations 0.6 (19.4) (14.1) (16.5) Other income, net 47.4 121.8 76.2 70.8 Interest Expense 0.0 (2.0) (0.6) (2.9) ----- ----- ----- ----- Income before income taxes 48.0 100.4 61.5 51.4 Provision for income taxes 0.0 0.0 0.0 0.0 ----- ----- ----- ----- Net income 48.0% 100.4% 61.5% 51.4% ----- ----- ----- ----- ----- ----- ----- -----
NET SALES The Company's total net sales decreased 2.3% to $3.8 million in the third quarter of fiscal 1999 from $3.9 million for the same quarter in fiscal 1998. Net sales for the first nine months of fiscal 1999 decreased 35.9% to $9.2 million from $14.4 in the same period of fiscal 1998. During fiscal 1998, the Company decided to focus its efforts on its digital video software product lines. Accordingly, during the latter part of fiscal 1998 the Company divested itself of its various hardware product lines, including the sale of its monitor business to KDS. Consequently, revenues for the current periods declined from comparable periods a year ago as current period revenues are almost entirely video software. Future sales will be predominately attributable to sales of software products since the Company's digital video product line is primarily software. Shipments of digital video products in the three month period ended June 30, 1999 were $3.7 million, an increase of 29% from the second quarter of fiscal 1999 and represented approximately 96.8% of net revenue. There can be no assurance that sales of these software products will continue to increase or that they will increase at the same growth rate experienced in fiscal 1999. The Company also experienced continued growth in direct and on-line sales, which represented 18% of net revenue in the third quarter of fiscal 1999 as compared with 15% of net revenue in the previous quarter. Revenue recognition related to software product sales is as follows: revenue from the sale of software, net of estimated returns, is recognized upon either shipment of the physical product or delivery of electronic product, at which time collectibility is probable and the Company has no remaining obligations. Sales to Ingram Micro, Canon U.S.A., Inc., Broadfield Distributing, and SGI Japan accounted for 16.5%, 20.5%, 10.5% and 10.3% of net sales for the third quarter of fiscal 1999, respectively. For the corresponding period of fiscal 1998, the same customers accounted for 57.2%, 0.0%, 1.8% and 0.0% of the Company's net sales. For the nine month period of -12- fiscal 1999, Ingram Micro and Canon U.S.A., Inc. accounted for 21.7% and 18.1%, respectively, as compared to 55.8% and 0.0% for the corresponding period of fiscal 1998. GROSS PROFIT The Company's gross profit margin was 66.8% and 63.6% for the three and nine month periods ended June 30, 1999, respectively, compared with 42.6% and 35.6% for the same periods in fiscal 1998. The increase in gross profit margin in fiscal 1999 was due primarily to increased sales of higher gross margin digital video software products. Also contributing to the increase in gross profit margin were overall efficiencies in the Company's distribution system. The gross profit margin for the three and nine month periods ended June, 1998 reflects the sales of discontinued monitors, color publishing, accelerated graphics and DOS on Mac products at very low profit margins. The Company anticipates the gross profit margins will be higher in fiscal 1999 as compared to the gross profit margins in fiscal 1998 due to the Company's decision to refocus its business on higher margin digital video software products. Additionally, the Company is taking further steps to reduce product costs and control expenses. However, there can be no assurance that the Company's gross margins will improve or remain at current levels. RESEARCH AND DEVELOPMENT EXPENSES Research and development expenses were $0.7 million or 17.9% of net sales in the third quarter of fiscal 1999 compared to $0.7 million or 19.1% of net sales in the same quarter of fiscal 1998. Research and development expenses were $2.0 million or 21.3% of net sales for the first nine months of fiscal 1999 and $2.1 million or 14.2% of net sales for the corresponding period of fiscal 1998. The increase in research and development expenses expressed as a percentage of net sales for the nine month period ended June 30, 1999 were primarily attributed to the decrease in net sales. The Company expects that decreases in its research and development expenses due to the divestiture of the monitor and color publishing business will be offset by increases in the expenses for the digital video product line and, therefore, expects to devote approximately $3.0 million to research and development during the entire fiscal 1999. The Company expects to continue to invest in research and development activities to support its goal of continued growth through the development of new and competitive digital software products. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $1.8 million or 48.3% of net sales and $5.2 million or 56.4% of net sales for the three and nine month periods ended June 30, 1999, respectively, compared to $1.7 million or 42.9% and $5.5 million or 37.9% of net sales for the same periods of the prior year. The Company increased its selling, general and administrative expenses in the three month period ended June 30, 1999 primarily due to sales and marketing efforts in Japan and Europe. The decrease in selling, general and administrative expenses year to date is primarily due to the reduction in personnel expenses resulting from the Company's efforts to refocus its business. OTHER INCOME, NET Other income was $1.8 million and $7.0 million for the three and nine month periods ended June 30, 1999, respectively, compared to $4.7 million and $10.2 million for the same periods in fiscal 1998. In the nine month period ended June 30, 1999, other income resulted primarily from $4.1 million in income from KDS, a reversal of approximately $0.6 million of previously accrued sales taxes as a result of settlement of various sales tax exposures in certain jurisdictions, and the release of approximately $2.2 million from escrow related to the 1996 divestiture of the Color Server Group. In the first nine months of fiscal 1998, other income resulted from the sale of approximately 537,000 shares of Splash Common Stock. INTEREST EXPENSE Interest expense was minimal in the third quarter of fiscal 1999 and $55,000 for the nine months ended June 30, 1999, compared with $78,000 and $416,000 for the same periods in the prior year. This decrease was due to the repayment of the working capital line of credit to IBM Credit in July 1998 and Silicon Valley Bank working capital line of credit in January 1999. -13- INCOME TAXES The Company did not record a provision for income taxes for the three and nine month periods ended June 30, 1999 and June 30, 1998 due to the availability of net operating loss carryforwards. FAS 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based on the weight of available evidence, the Company has provided a full valuation allowance against its deferred tax assets. The company will continue to evaluate the realization of the deferred tax assets on a quarterly basis. NET PROFIT As a result of the above factors, the Company had a net income of $1.8 million and $5.7 for the three and nine months ended June 30, 1999, respectively, compared to a net income of $3.9 million and $7.4 for the three and nine months ended June 30, 1998. LIQUIDITY AND CAPITAL RESOURCES The Company's cash and cash equivalents increased to $3.1 million at June 30, 1999, a $2.5 million increase from September 30, 1998. The increase in the Company's cash and cash equivalents was primarily attributable to funds received from the Splash escrow and income from the license agreement with KDS which was offset by funding of operating losses of the Company. The Company had working capital of $1.3 million at June 30, 1999. During the third quarter ended June 30, 1999, the Company invested $1.8 million in highly liquid investments with maturities of three months or less at date of acquisition to primarily minimize principal risk and maintain liquidity. Approximately $0.1 million of the $3.1 million of cash and cash equivalents available at June 30, 1999 was restricted under a letter of credit. Under the license and asset transfer agreement with KDS, the Company transferred its Radius, Supermac, PressView and certain other trademarks to KDS and licensed certain intellectual property pertaining to PressView and PrecisionView monitors. The value of the transaction was $6.2 million. On May 17, 1999, the Company completed the sale of its monitor and color publishing business to KDS. In connection with this transaction, the Company received the sum of $1.0 million, which represents the prepayment of three installment payments on the promissory note related to the license agreement. In July 1999, the Company received the final installment on the note. The Company believes that its cash and cash equivalents, cash flow from operations, and other sources of financing, will be sufficient to fund operations for at least the remainder of this fiscal year. However, there can be no assurances that the sale of software products will continue to increase to a sufficient extent to offset the loss of revenues and gross margin from the monitor business. The Company may need to further reduce its operating expenses or seek additional sources of working capital if software product sales do not increase at the rate assumed in the Company's current operating plans. The Company and its management believe that other sources of financing will be available and that it can further reduce such operating expenses, if necessary. The Company anticipates that it will have cash available for its ordinary course of business operating expenses. Although the Company has achieved favorable trade terms with its critical vendors, certain suppliers may put the Company on a cash or prepay basis and/or require the Company to provide security for their risk in procuring components or reserving manufacturing time. In the event the Company were unable to generate sufficient net sales or if the Company incurs unforeseen operating expenses, it may not be able to meet its operating expenses without additional financing. CERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S FUTURE RESULTS OF OPERATIONS A number of uncertainties exist that could affect the Company's future operating results, including, without limitation, the following factors: the Company's ability to sustain profitability; the Company's ability to successfully conclude its litigation with -14- Intelligent Electronics, Inc. and Splash shareholders; the success of the Company's digital video software products; the success of the Apple Macintosh computer line and operating system, the success of Apple, as well as the Company's ability to compete successfully with Apple in its markets, including the non linear digital video editing software market; the success of Apple's Quicktime technology for Windows; favorable licensing terms for Quicktime from Apple; the Company's reliance on Adobe Systems for products which are bundled with the Company's products; the Company's ability to successfully develop, introduce and market new software products, including products for the Windows operating system, to keep pace with technological innovation, particularly in light of its limited financial resources; the Company's ability to compete in the digital video software market, including with Apple; the ability of the Company's manufacturers and suppliers to deliver components and manufacture the Company's products; the Company's ability to achieve Year 2000 readiness in its business operations and its dealings with significant third parties; the Company's reliance on international sales and its new distributor arrangements with respect to Europe and Japan and with Canon; the Company's ability to attract and retain its key personnel; and the risk factors identified from the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1998. IMPACT OF YEAR 2000 The year 2000 Issue ("Y2K Issue") is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, distribute via Internet, or engage in similar normal business activities. The Company's plan to resolve the Y2K Issue involves the following four phases: assessment, remediation, testing, and implementation. To date, the Company has fully completed its assessment of all internal systems and products that could be significantly affected. The assessment of risks associated with suppliers and distributors is not yet complete. Based on recent assessments of its information management and accounting systems, the Company has determined that it will be required to modify or replace significant portions of its software and certain hardware so that those systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with such modifications and replacements, the Y2K Issue can be mitigated without a material adverse impact on the Company. However, if such modifications and replacements are not timely made, the Y2K Issue could have a material impact on the operations of the Company. None of these systems interoperate directly with the systems of suppliers or distributors. Based on a review of its product line, the Company has determined that primarily all of the products it has sold and will continue to sell do not require remediation to be Year 2000 compliant, as primarily all operate in conjunction with the MacOS. Accordingly, the Company does not believe that the Y2K Issue presents a material risk with respect to the Company's products. The Company is approximately 75% through the remediation phase with respect to its information management and accounting systems and expects to complete software and hardware replacement no later than September 30, 1999. Once the software and hardware is replaced for a system, the Company begins testing and implementation. These phases run concurrently for different systems. Completion of the testing phase for all significant existing software systems was completed as of January 31, 1999, with all remediated systems to be fully tested and implemented by December 31, 1999. None of the Company systems interface directly with significant third party suppliers. The Company is in the process of working with third party suppliers and distributors to ensure that any Company systems that could interface directly with third parties are Year 2000 compliant by December 31, 1999. Remediation and testing of all significant systems is expected no later than December 31, 1999. The Company believes that its key suppliers, two of whom are sole sources, are in the process of making their billing systems Year 2000 compliant. The Company is not aware of any supplier or distributor with a Y2K Issue that would materially impact the Company's results of operations, liquidity, or capital resources. However, the Company has no means of ensuring that such suppliers and distributors will be Year 2000 ready. The inability of suppliers and distributors to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. There are no vendors that could not be replaced in a reasonable period of time, except for transport vendors. The failure of Fedex, UPS, Airborne and the U.S. Mail would impact direct sales. The effect of this occurrence is not determinable. -15- The Company will utilize both internal and external resources to reprogram, or replace, test, and implement the software and operating equipment for Year 2000 compliance. The total future cost of the Year 2000 compliance is estimated at approximately $500,000 to $600,000 and is being funded through net cash flows or capital leases. Some of these expenditures were likely to have been made in the ordinary course of upgrading and replacing obsolete systems without regard to the Y2K Issue. Through the third quarter of fiscal 1999, the Company has incurred less than $100,000 related to all phases of the Year 2000 project and assumes that most of the new system cost will be funded via leasing. Management of the Company believes it has an effective program in place to resolve those aspects of the Y2K Issue within its control in a timely manner. As noted above, the Company has not completed all necessary phases of the Year 2000 program. In the event that the Company does not complete these phases, the Company would be unable in some degree to take customer orders, manufacture and ship products, invoice customers and collect payments. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. The Company could be subject to litigation for computer systems product failure, for example, equipment shutdown or failure to properly date business records. Furthermore, although management is not aware of any Y2K Issue with products sold, there can be no assurance that the use of such products alone or in conjunction with other products will not malfunction and expose the Company to liability. The amount of potential liability and lost revenue associated with these risks cannot be reasonably estimated at this time. The Company has contingency plans for certain critical applications and is working on such plans for others. These contingency plans involve, among other actions, manual workarounds, increasing inventories, and adjusting staffing strategies. All of the Company's production, shipping, purchasing, billing and inventory functions could be accomplished via outsource vendors that are currently readily available, although there can be no assurance that such vendors will be available on reasonable terms as the millennium approaches. The above discussion regarding costs, risks and estimated completion dates for the Year 2000 is based on the Company's good faith estimates based on information that is currently available, and is subject to change. As the Company continues to progress with this initiative, it may discover that actual results will differ materially from these estimates. -16- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 3 to Consolidated Financial Statements - Commitments and Contingencies. ITEM 5. OTHER INFORMATION Possible Delisting from Nasdaq SmallCap Market: As of June 30, 1999, the Company had assets of $5.5 million and total liabilities of $4.8 million and therefore had net tangible assets of $0.7 million. In order for the Company's Common Stock to continue to be listed on the Nasdaq SmallCap Market, the Company will be required to maintain net tangible assets of at least $2.0 million, or must have net income in its most recently completed fiscal year or in two of the three prior fiscal years. The Company had net income in fiscal years 1997 and 1998. However, in the event that the Company does not increase its net tangible assets to greater than $2.0 million, the Company's Common Stock would be subject to delisting if it also failed to achieve net income for its next two fiscal years. On June 1, 1999, Charles Berger resigned as a director and the Board of Directors appointed Carl Rosendahl to the newly vacant Board seat. Mr. Rosendahl is Chairman of Pacific Data Images, Inc. "PDI", a privately held Palo Alto company employing about 300 employees founded in 1980 by Mr. Rosendahl to combine interests in filmmaking and computer graphics. PDI is an award winning producer of high-end animation and visual effects for the feature film, commercial and entertainment industries. PDI has a co-production pact with DreamWorks SKG to create original, computer animated feature films, including the movie ANTZ for which Mr. Rosendahl was executive producer. The Academy of Motion Picture Arts and Sciences recognized PDI and its founders in 1998 with a Technical Achievement Award for the concept and architecture of PDI's proprietary animation system. Mr. Rosendahl holds a BSEE from Stanford University (1979), has taught a graduate level course entitled "Computer Animation and Visual Effects for Film and Television" at USC Film School in 1993 and 1994 and is a member of ACM SIGGRAPH and the governing board of directors of the Visual Effects Society. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS The following exhibits are filed with this Quarterly Report: 27.01 Financial Data Schedule (EDGAR version only). (b) REPORTS ON FORM 8-K On May 28, 1999, a report pursuant to Items 2 and 7 of Form 8-K was filed by the Company relating to the sale of the its monitor and color publishing business. Such sale was previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1998 and the Company's Quarterly Reports on Form 10-Q for the quarters ended December 31, 1998 and March 31, 1999. Pro forma financial information relating to the sale of the monitor and color publishing business was included therewith. -17- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: August 13, 1999 DIGITAL ORIGIN, INC. By: /s/ MARY F. BOBEL ------------------------ Mary F. Bobel Chief Financial Officer -18- EX-27.01 2 EXHIBIT 27.01
5 1,000 9-MOS SEP-30-1999 JUN-30-1999 3,121 0 5,203 (3,757) 264 5,267 6,892 (6,844) 5,503 4,016 0 0 0 169,183 (168,496) 5,503 9,249 9,249 3,367 3,367 7,186 0 55 5,689 0 0 0 0 0 5,689 1.03 1.00
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